Saturday, June 15, 2013

The Banana Republic Revisited?

We took the view in the 1970s – it’s the old cargo cult mentality of Australia that she’ll be right. This is the lucky country, we can dig up another mound of rock and someone will buy it from us, or we can sell a bit of wheat and bit of wool and we will just sort of muddle through … In the 1970s …we became a third world economy selling raw materials and food and we let the sophisticated industrial side fall apart … We must let Australians know truthfully, honestly, earnestly, just what sort of international hole Australia is in. It’s the price of our commodities – they are as bad in real terms since the Depression … If this government cannot get the adjustment, get manufacturing going again and keep moderate wage outcomes and a sensible economic policy, then Australia is basically done for … If in the final analysis Australia is so undisciplined, so disinterested in its salvation and its economic well being, that it doesn’t deal with these fundamental problems … the only thing to do is to slow the growth down to a canter. Once you slow the growth under 3 per cent, unemployment starts to rise … Then you are gone. You are a banana republic.

(Paul Keating speaking on a wall phone in the kitchen of a function centre to radio personality John Laws on 14 May 1986, cited in Richard H. Snape, Lisa Gropp and Tas Luttrell (1998) Australian Trade Policy: 1965-1997, Sydney, Allen & Unwin, pp. 84-5.)

Revisiting Paul Keating's Banana Republic warning should remind us how economic conditions change and how they keep changing: how new 'realities' quickly become replaced by newer 'realities' masquerading as permanent changes.

Resources have been good for Australia, unlike for some other countries where there really has been a resource curse. However, with the end of the boom it is likely that we will revisit some of the earlier concerns about Australia's over-reliance on resources.

Another quote from the Labor government in the early 1990s also seems particularly relevant at the moment.

This tough, increasingly competitive world of five and a half billion people does not owe, and will not give, seventeen million Australians an easy prosperity. The days of our being able to hitch a free ride in a world clamouring, and prepared to pay high prices, for our rural and mineral products, are behind us. From this fact flows everything else.

This sentiment was true for the 1980s and early 1990s, but less so for the 2000s where rising prices for resources and increases in national income provided an easier prosperity than Hawke might have imagined.

In 2000, Keating was still arguing against the resources as saviour view of long-term Australian prosperity:

The global terms of trade will not suddenly flow back in the direction of commodity producers. So even if we wanted to, we can never again rely on export wealth generated by Australian farmers and miners to pay for the preservation of tariff walls to protect our manufacturing and services sectors from competition.

China
changed everything. Its voracious appetite for resources pumped up the
prices Australia received for its resource exports – particularly coal and
iron ore. All the warnings of the past were quickly forgotten as resource wealth became the new reality masquerading as a permanent change. Increased prices then led to a huge investment boom, which in recent years has been centred around gas. The scale of this boom has been remarkable as a recent report from the Australia's Bureau of Resources and Energy Economics (BREE) shows.

But this investment boom has now peaked and Australia must now find new sources of growth. According to BREE, the "likely scenario" is that

the value of projects currently at the Committed Stage is scheduled to moderate after 2013 as a result of the completion of mega projects currently under construction. In 2014 the stock of committed investment is expected to decrease by $8 billion, and then by a further $63 billion in 2015. From 2017 onwards, the stock of committed investment in the mining sector is projected to revert back to levels comparable to 2007.

While some commentators, including the Reserve Bank Governor, argue that we are now entering the third – export – stage of the boom, it is likely that just as the boom surprised us on the way up, the crash will surprise us on the way down.Australia will no doubt export more for at least a few years, as recent data shows, but with increased global supply and lower prices, it is likely that we'll start worrying about our dependence on resources once again.

Recent data clearly shows that commodity prices are on the decline, with iron ore and coal prices substantially lower. According to the RBA:

Over the past year, the index has fallen by 8.6 per cent in SDR terms. Much of this fall has been due to declines in the prices of coking coal, iron ore and thermal coal. The index has fallen by 9.9 per cent in Australian dollar terms over the past year.

For an explanation of the RBA's Index of Commodity Prices and recent changes see here.

Base Metal Prices﻿

Base metals include aluminium, copper, lead, nickel and zinc.

Bulk Commodity Prices﻿

Bulk commodities include iron ore and coal (thermal and metallurgical).

The Economist also notes the general fall in a range of commodities in USD terms in recent times.

Australia is a lucky country, but it is also a vulnerable country. Australia's historical vulnerability to declines in international demand for resources are about to re-emerge, which will make economic management a difficult task for a new government. Things have been tough for the Rudd and Gillard governments, but they will be even tougher for an Abbott government. Labor was helped by the investment-led revitalisation of the Chinese economy, but the Coalition will come into office at a time of Chinese economic consolidation and rebalancing and, possibly, economic stagnation.
In the late 1980s when some commentators were eulogising about the end of the industrial revolution and touting the beginning of the information age, Australia appeared to be doomed unless it weaned itself off a reliance on resources. This new reality was superseded by an even newer one - the remarkable rise of the Chinese economy. Not only did Chinese demand increase the price of Australian exports, but it also decreased the price of Australian imports. Manufactured imports became cheaper. Remember that the terms of trade - the average price level of exports in relation to the average price level of imports - is a ratio (or fraction) and so can be affected by both the numerator and the denominator.

The terms of trade improved remarkably from the early 2000s, it then declined as commodity prices fell in the immediate aftermath of the global economic crisis. To the surprise of many, including myself, it then ascended again to new heights as China embarked on a renewed investment boom, a boom that required many of the things that Australia exports. There can be no denying that Australia has been lucky to be in a position to take advantage of China’s industrialisation and widespread Asian exceptionalism in the face of a slow American recovery and continuing European crisis. Similarly, however, any downturn in China and other Asian economies will now negatively affect Australia.